Income Tax Rate Changes

As the majority of Americans who follow the news know, we're at a very critical and sensitive point in time right now when it comes to the country's economy and finances. We have record high national debt and a huge federal budget deficit, a slowly recovering but still struggling economy, slow economic growth, and a most disturbingly high 9.5% official unemployment rate, which in reality, when underemployment is counted, is actually close to if not over 16%!

At the same time we are still fighting two expensive wars with associated nation-building type programs in Iraq and Afghanistan, providing substantial costly aid of many different types to many other countries, including Pakistan and Haiti, and maintaining dozens of marginally needed military bases in still others. Expenses and investments for these activities are one reason for our high debt and budget deficits. Another important reason was because of the federal initiatives and interventions considered necessary by the Obama Administration to help the country recover from our deep recession from 2008 to the present.

A third important factor was the sizable tax cuts pushed by President Bush and approved by Congress in 2001 in the Economic Growth and Tax Relief Reconciliation Act and other related legislation passed in 2003. The lowest income tier rate was reduced from 15% to 10%, the other tier rates were reduced by 2% each. The Act also reduced the capital gains tax, increased the child tax credit and reduced the so-called "marriage penalty". The stated purpose of the Act was to help us recover from the 2000 recession and stimulate economic growth. As most of us know, these tax cuts are scheduled to expire at the end of the year and revert to their former higher levels for 2011 and future years, unless Congress enacts legislation to prevent this.

President Obama has for some time indicated that he wants to see the current rates extended into 2011 and beyond for all income tiers, except for those households earning $250,000 or more annually, believing that these high earners can more easily afford to pay more. Additionally, he is very cognizant of the need to work on reducing our deficit and demonstrate to our creditors, including the Chinese, that we're serious about stabilizing our finances. Most of the Republicans in Congress are opposed to any higher tax rates, feeling that it has a good chance to weaken our economic recovery and harm many small businesses who are key players in potentially hiring a lot of new employees when the economy gets a little better and credit becomes more readily available.

According to the nonpartisan Tax Foundation, a typical middle-class family with a median income of $63,366 would pay $4,964 in taxes next year if the tax cuts expire, well above the estimated $3,423 the family would owe if the cuts were extended. So the difference is a little over $1,500, a fairly significant amount for a family in this position, having most likely limited savings and money to pay for any of their children's college education and their retirement. If all the tax cuts were allowed to expire through congressional inaction, something I consider highly unlikely, an estimated $3 billion would come to the U. S. Treasury over the next 10 years, an average of $300 billion annually. Considering that the federal budget deficit for the current fiscal year is projected by the White House to reach a record $1.47 trillion, and maybe a comparable level next year, it would certainly be tempting to let the cuts expire. But that won't happen.

Chances are good that President Obama will eventually either get his the bulk of his plan approved or will get a compromise approved, under which the reinstatement of the former higher rates for those earning over $250,000 would be phased in over two years. I also think there is a chance that tax rates for most of our middle class will go up a little from 25% to 26% or 27% in two more years, assuming the economy has largely recovered and the unemployment rate has declined to something like 7% or less. The most important index for Washington policies and public opinion polls in the next 18-24 months is the official unemployment rate. Tax rates will tend to stay relatively low, like now, if the unemployment rate stays above 8.5 or 9.0% and are more likely to increase if and when the rate approaches 7.0 or even 7.5% or goes even lower.

It is important to note that economists and other academics seem to be evenly divided between Obama's plan and that supported by most Republicans in the opposition. In my view, the major factors that will influence the outcome over the next 4-6 months, aside from changes in the unemployment rate include especially what happens in the November mid-term elections, new economic growth numbers, the latest developments in Iraq and Afghanistan, and revised numbers for the federal budget deficit.

I'm OK with what I understand of Obama's plan for the tax rates, given current economic and financial conditions, but, as mentioned in earlier posts, I also want to see comprehensive tax reform enacted next year where the entire tax system is greatly streamlined and simplified with reduced "administrative" costs for both the government and taxpayers. It will take a lot of time, in short supply bipartisan effort, and comprise to get what I support approved by Congress. Reform will definitely be opposed by tax lawyers and tax accountants, as well as other groups who are happy and make a good living with the status quo, but it is close to a no-brainer and will be good for America.